Pension Obligation Bonds
There are many benefits that come with employment whether in public or private sectors. Many governments globally have embraced great strategies that help meet a number of financial objectives. Use of pension obligation bonds [POBS] is one strategy that has allowed many states fulfil their pledges to its citizens. POBs are types of bonds issued by government to take care of its obligation to the pension system in which its employees are recognized members.
POBs have been popular with many state and local governments as they are advantageous although their also come with a few disadvantages. Pension obligation bonds are a great way for state and local government to embrace, but there is a lot for the involved team to consider. First and foremost, POBs fall under two great categories and they are;
- Unfunded Actuarial Accrued Liability (UAAL) – This is the amount by which the estimated pension fund falls than the amount that is necessary. This also occurs without any payment from the state on what is already earned by the current or retired employees or covered by the pension system.
- Normal annual contribution- Here, the state government is also required to pay certain amount to the pension fund annually in respect to present benefits that are earned by current employees sheltered by the pension fund.
Pension obligation bonds play great role for any local or state government. Reasons for issuing POBs vary from one issuer to another issuer and are impacted by time, economic condition and many other situations. Here are a few advantages as to why many governments prefer issuing POBs;
- POBs act a classic interest rate savings pay back. This is because government is required to make payment in respect to its UAAL and if the bond rates are low, POBs can offer a better way to save more on the refunds.
- They act as a great way to renegotiate other terms of pension responsibility and discounts for early payments.
- They are also used for budget relief during significant budget insufficiencies.
- Pension obligation bonds offer governments an opportunity to enhance relations with employees and their unions especially funding unfunded pension debt.
- POBs are better than paying more into the pension fund or asking employees to pay more into the pension fund scheme.
Despite the aforementioned benefits of pension obligation bonds, there are notable disadvantages that involved parties should be well-acquainted with. They include;
- State governments can easily make negotiations and change pension obligations and postpone payments.
- Pension fund will have undesirable earnings in case of an interest drop below the bond interest rate.
- In case of higher earnings on the pension fund, overfunding is likely to occur and lead to an increase on retirement benefits than expected.
- All POBs are taxable and those with fixed rates are sold as noncallable bonds.
Pension obligation bonds are great tools for financially sound governments. Economic growth over the years has enhanced the performance of POBs in many nations. However, prior to issuing any pension obligation bonds, it is wise for every government entity to conduct a cautious financial analysis and ensure that the POBs are controlled in a manner that does not give away the prime payments.
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